We're all wrong about the bull market

Michael A. Gayed, CFA, winner of the 2014 Dow Award, is chief investment strategist and co-portfolio
manager at
Pension Partners, LLC., an
investment advisor which manages mutual funds and separate accounts according
to its ATAC (Accelerated Time and Capital) strategies focused on inflation
rotation. Prior to this role,
Gayed served as a portfolio manager for a large international investment group,
trading long/short investment ideas in an effort to capture excess returns. From
2004 to 2008, Gayed was a strategist at AmeriCap Advisers LLC, a registered
investment advisory firm that managed equity portfolios for large institutional
clients. In 2007, he launched his own long/short hedge fund,
using various trading strategies focused on taking advantage of stock market
anomalies. Follow him on Twitter @pensionpartners and YouTube
youtube.com/pensionpartners.

I'm a huge fan of behavioral finance. Numerous studies have shown that the volatility of price movement can not be explained by traditional fundamental analysis and economic trends. When dealing with public markets, every trader and investor is dealing with the madness of the crowd, which continuously goes through periods of underreactions and overreactions.

Behavior and psychology, then, largely explain how bull and bear markets occur regardless of whether you are looking at bonds, stocks, commodities or currencies. As I like to always say, my opinion and your opinion do not matter. The only thing that matters is the opinion of who you are selling to (Mr. Market) — that's who sets price.

In behavioral finance, there are a number of biases that individuals tend to exhibit, which then leads to certain viewpoints about the world, which in reality, may actually be incorrect.

"Good managers have a bias for action."
—Tom Peters

The one bias that I believe most defines 2013 so far given the run up in the S&P 500 is something called the home bias, which is defined by Investopedia as "the tendency for investors to invest in a large amount of domestic equities, despite the purported benefits of diversifying into foreign equities."

I would take this definition a step further by arguing that home bias causes people to completely ignore asset allocation at the extreme altogether, even though numerous studies and research show that a mix of stocks, bonds, commodities and currencies tends to perform well over time.

I have spoken to many advisors who are invested in our ATAC strategies used for managing our mutual fund and separate accounts over the past several weeks, and the theme most consistently stated by them is their frustration with their clients wanting nothing but U.S. stock exposure. Their various asset allocation mixes have resulted in "underperformance" against the S&P 500.

Why? Because its hard to beat the S&P 500 when the S&P 500 is the only game in town. Anyone who has anything but U.S. stocks is not keeping up. Hold European equities
VGK, -0.36%
? Emerging markets
EEM, -0.27%
? Gold
GLD, -1.12%
? Silver
SLV, -1.85%
? Bonds
TLT, -0.18%
? Commodities
DBC, -0.89%
? Even a marginal allocation to anything outside the U.S. has not performed as well as the U.S.

And yet, everyone is screaming about the bull market. Home bias is making people only look at the U.S., ignoring how disappointing and downright bad nearly everything else around the U.S. has been.

Take a look below at the price ratio of the iShares S&P Moderate Allocation Fund ETF
AOM, -0.26%
relative to the S&P 500
SPY, +0.06%
As a reminder, a rising price ratio means the numerator/AOM is outperforming (up more/down less) the denominator/SPY. For a larger chart, please click here.

This ETF is a mix of bonds and stocks both domestic and abroad. Note the severe underperformance a benchmark moderate allocation fund has experienced all year. Year to date, AOM is up 4.5%. Raging bull market? Not so much.

My broader point here is very simple — do not look at the world through rose-colored S&P 500 glasses. Home bias is making everyone believe this is the 1990s again, but anyone who has had anything but the S&P 500 very much disagrees. Such unrelenting outperformance means caution should be warranted. Either the S&P 500 is wrong and falls to adjust for the lackluster performance of everything else, or your money may be better treated in laggards on the verge of a turnaround.

A few fat pitches come to mind...

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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